US recession: Manufacturing already in contraction – but EUR/USD may still fall

• US ISM Manufacturing PMI shows contraction that indicates growing chances of a recession.
• The US dollar dropped on growing chances for a Fed cut.
• EUR/USD gains may come to an end ahead of the ECB decision.

The US manufacturing sector may be contracting – indicating a recession. ISM' Purchasing Managers' Index (PMI) for the manufacturing sector has plunged to 49.1 points in August – far below 51.1 expected and 51.2 reported in July. 

The drop below 50 points means that the industry has moved from expansion to contraction. The ominous forward-looking figure – which is the worst in three years – joins a plunge in US consumer confidence. Personal consumption has held up the economy while investment has been dropping. That consumption survey showed weakness in sales, while today's ISM figure is showing that the lack of investment may be hitting the manufacturing sector.

The soft and hard data join the yield curve inversion that is known as an early indicator of a recession.

Investors reacted by rushing into the safety of bonds thus pressuring yields lower. In turn, these yields point to higher chances of the Fed cutting interest rates and the US dollar dropped. EUR/USD has bounced to a high of 1.0975 after setting fresh two-year lows at 1.0925 earlier today.

Can EUR/USD continue upward?

Not exactly. Starting from the short-term, the European Central Bank is set to introduce a stimulus package next week. The options range from a 10 basis point deposit rate cut to a deeper cut a new bond-buying scheme. The Federal Reserve announces its decision in the following week. The timing implies limited gains for EUR/USD. 

Looking at the broader picture, the US economy may undergo a recession – but Germany is probably already experiencing one. The German economy shrank in the second quarter by 0.1% while the euro-zone expanded by 0.2%. However, the US economy grew by a healthy 0.5% – around 2% annualized. 

The main factor for the downfall in confidence is the US-Sino trade war. Weaker business sentiment impacts investment decisions and the future of the economy. However, the damage inflicted on China is greater than the one suffered in America. Germany's robust post-crisis growth depended heavily on exports to the Asian giant – and is now struggling.

And in general, when the US economy catches a cold – the rest of the world suffers a flue. Even if EUR/USD were to gain in the next few weeks – the direction remains down.

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